This was probably inevitable: The U.S. Federal Trade Commission (FTC) has officially launched an investigation into OpenAI, the company that created the viral generative artificial intelligence (AI) app ChatGPT. It's just the latest attempted crackdown on big tech as the federal agency has made it clear it wants to rein in the power of digital business behemoths. What's it to Microsoft (MSFT 1.44%)? Just $10 billion; chump change for the old software giant, but possibly also hopes and dreams of leading the world into an AI-powered future.
Should Microsoft investors be worried about this development?
The FTC targets a Microsoft investment -- again
The FTC's investigation into OpenAI comes to us via a leak from The Washington Post. In a letter sent to the AI company, the FTC is inquiring, in part, as to whether OpenAI has "(1) engaged in unfair or deceptive privacy or data security practices or (2) engaged in unfair or deceptive practices relating to risks of harm to consumers, including reputational harm."
OpenAI's chatbot service, ChatGPT, utilizes what is known as a "large language model" (LLM) to enable human-like conversations with users. The LLM was reportedly trained on massive amounts of data (using chips designed by Nvidia (NVDA -3.89%)) available on the internet over the last few years. Besides complaints from creators (writers, artists, etc.) that their work was unknowingly used to train the LLM, ChatGPT is known to sometimes provide inaccurate or false information when asked questions.
The FTC's investigation looks like it will be wide-ranging. The agency is requesting OpenAI furnish it with information regarding the training of its LLMs, who customers are and how much they pay for access to those LLMs, how consumers are marketed to, and safeguards OpenAI has in place to govern the responses ChatGPT provides users.
Microsoft announced it was investing $10 billion into OpenAI early in 2023. This investment isn't the only one that has been targeted by the FTC this year. The FTC has also opposed Microsoft's acquisition of leading video game publisher Activision Blizzard (NASDAQ: ATVI) for a much larger sum of about $70 billion, citing concerns about limiting consumer choice and access to games. An appeals court has since denied the FTC's motion and cleared Microsoft to proceed with the Activision Blizzard takeover.
Is Microsoft's OpenAI investment toast?
To be clear, an investigation like this one can take many months, even years before some sort of legal resolution is arrived at (or for nothing to come of the investigation at all). There's no need for investors to panic, though the situation is certainly worth monitoring.
$10 billion may sound like a big bet, but it's a relatively small amount for highly profitable and deep-pocketed Microsoft.
Data by YCharts.
One thing could become problematic. It's become clear that big software companies believe generative AI services like ChatGPT are the future. Microsoft's investment in OpenAI (again, thanks in no small part to Nvidia's leading chip system designs) and subsequent move to infuse AI across its cloud computing software portfolio have set off a type of AI arms race among cloud infrastructure providers.
Any action levied against OpenAI could hobble Microsoft's hopes of leading this new AI industry going forward or hinder it from keeping up with big tech peers in the AI race. But it's simply too soon to tell if such risk will materialize or not.
The real risk facing Microsoft right now
Rather than fret over AI and the FTC, I believe the real threat to an investment in Microsoft right now -- especially an investor mulling whether to buy the stock now or not -- is valuation. Microsoft shares trade for a whopping 37 times trailing-12-month earnings. Granted, profit margins have come under pressure in recent quarters due to a slowdown in cloud spending and the effects of interest rate hikes. Nevertheless, buying right now would imply a belief Microsoft will experience substantial growth in the next few years.
The good news is that the market thinks Microsoft profits will indeed rally. Shares trade for just 27 times expected earnings for next year -- still a premium price tag, but certainly not a totally unreasonable one.
Nevertheless, after a huge run-up in stock price in 2023, thanks to the AI hype cycle, I think new investors would be best served being patient before buying here. I rank Microsoft stock a "wait-and-see" as it will take time to realize positive benefits from its investment in generative AI.
